To quote Bank of England Governor, Melvin King in 2010 “of all the many ways of organising banking, the worst is the one we have today.” As I documented in part one, the Bank of England continues as a thoughtful critic to this day. And as we’ve seen there, but will see further below, that’s not so true of our central bank the Reserve Bank of Australia (RBA).

But first let’s have a quick tour of the horror show to which King was referring.

The fatal flaw in banking is that, although the money in our economy is a classic public good, like the air we breathe or the radio spectrum, it’s privately created. Commercial banks like NAB or Westpac create money whenever they advance a loan. This private licence to print money produces four huge problems.

First the banking system – and with it the economy – seizes up if private banks take excessive risks and go bust. In bailouts governments typically socialise the losses long after shareholders and executives have privatised the profits in hefty dividends and bonuses. And when you hear people say Australia didn’t bail out the banks – don’t believe them. None went under because the banks lobbied for emergency guarantees for hundreds of millions of dollars and, with all hell breaking loose around the world, the government capitulated over a weekend.

Second, public officials manipulate the banks’ creation of money by influencing the appetite for bank lending (through the overnight cash rate). But borrowing and lending reflect ‘animal spirits’ which strongly reinforce the economic cycle. And manipulating animal spirits is notoriously tricky. We often watch repeated interest hikes or cuts fail to turn things around. This happened as rate rises failed to moderate the exuberance of the boom in the late 1980s – until they overdid it. It’s been happening ever since the financial crisis as we’ve been shown that, until confidence returns, interest rate cuts can ‘push on a string’ and are ineffective in increasing credit and investment.

Third, with surging surpluses from saving countries like China, Germany and the Middle East for decades now, other countries have been relieving themselves of the discomfort of sluggish growth by increasing debt at the risk of even greater trouble ahead. Are you feeling lucky?

Fourth: if private banks creating money sounds a bit dodgy, it is. Economic reform reins in these kinds of privilege in other areas. Thus where it was once allocated to the lucky few, much radio spectrum is now auctioned, generating billions in government revenue. But here’s the thing. If governments created the money supply it would bring in tens of billions, perhaps a hundred billion in revenue.

What created money really funds

Indeed, in 1933 at the nadir of the Great Depression, economists from the University of Chicago proposed that governments monopolise money creation. A young Milton Friedman championed the ‘Chicago Plan’ after WWII and for the rest of his professional life.

The textbook concern with this approach is that preventing private money creation will starve business of credit for working capital and for investment. Yet today, banks focus mostly on secured lending against mortgages, which for whatever benefits it generates, also underwrites an arms race in property prices and that does nothing for house buyers in aggregate and indeed imposes substantial costs once one takes into account the increasing financialisation of housing – the increasing payments to banks.

In fact only around 10% of bank lending finances business operations. As the Great British economic journalist Martin Wolf explains, if we’re worried about this “we could find other ways of funding this”. Wolf goes on to outline the upside. If money growth was held to just 5% annually, the ‘seigniorage’ from government money issue would be around 4% of GDP. Leaving aside my own rough figuring which suggests Wolf’s numbers are excessively conservative – 4% of Australia GDP is 70 odd billion dollars of government revenue per annum!

When a government competes

I’ve proposed a less radical plan – Chicago Lite if you will. You know how government agencies shouldn’t use their special advantages of being government agencies – like tax and planning exemptions – to compete unfairly with private firms? This principle of ‘competitive neutrality’ has been a staple of economic reform for decades.

But it cuts both ways. To prevent bank runs and stabilise liquidity in the system, the government-backed central bank goes banker to the banks. They can borrow or lend from the central bank at the cash rate and use central bank ‘exchange settlement accounts’ to make payments between themselves. If they get those services from the central bank why can’t we all?

This was a moot point before the internet made it cheap to do.

But Australia’s Reserve Bank Governor Philip Lowe recently dismissed such ideas. Given the remaining problems in banking – of price gouging and instability – and the magnitude of the possible upside, you’d think he might have quoted some research: Research like the Bank of England’s which released research on a different Chicago Plan Lite.

Modelling the central bank creating a third of the money supply by issuing its own ‘bitcoin’ style crypto-currency, their simulations suggested huge economic gains of 3% of GDP – more than the PC’s estimated gains from national competition policy throughout the 1990s.

Regarding my proposal for ‘central banking for all’, Lowe was dismissive, claiming that it would put the RBA in competition with the banks. For me, that’s a feature, not a bug. Genuine economic reformers might see it that way too. They should. Especially in a sector saturated with excessive profits and bonuses – shouldn’t we at least consider levelling the playing field between banks and their customers? They bank with a ‘people’s bank’ – the RBA – but we can’t.

Of course, as the Bank of England paper noted, there are plenty of issues to be worked through. But none that can’t be managed using standard principles like everyone meeting the full, unsubsidised costs of services they receive. The Governor’s other concern – which extends also the issue of central bank digital currency – is that anything that makes it easier for people to avoid depositing money with commercial banks threatens financial stability. Again I see this as a feature, not a bug – or perhaps an opportunity dressed as a problem. If the little people are still fleeing for safety while the smart money has long since departed, shouldn’t we be asking why rather than lament their refusal to keep pretending?

Let’s debate reform’s winners and losers

Of course, Lowe’s concerns shouldn’t be ignored. But they should be the beginning, not the end of our exploration for the best options. As I read Lowe’s speech I thought of the old Tariff Board of the early 1960s which would have been reluctant to countenance tariff cuts to our highly protected car industry (It recommended a local content plan in 1965). Why? Well because it would make life difficult for car manufacturers. Later it came to understand that the whole point of a level playing field was that you can’t make things better for the best without making them tougher for the worst).

Or our Tax Office, which opposed Australia’s pioneering use of the tax system in administering HECS because using its infrastructure to facilitate student loans would interfere with the Tax Office’s real purpose.

If the Bank of England’s research is to be believed, reforming our monetary system offers economic reform with benefits on a grand scale. Is it really asking too much of our own central bank, replete with substantial research capacity, protected with independence other civil servants could only dream of, to deliberate on such important matters with its lodestars being reason, evidence and the public interest rather than the interest and comfort of the sector it regulates?

Postscript – Complacency, what complacency?

In an earlier version of this column, I suggested that the Productivity Commission might be sympathetic to my argument that RBA competition with the banks was a feature, not a bug. In any event, in that spirit, Lateral Economics made a submission to the Productivity Commission’s recent inquiry into competition in financial services outlining the proposal. Silly me. The Commission has just released its draft report. It is over 600 pages so I can’t claim to have read it all. But there’s no sign of it that I can see and, on subjecting it to a word search, “Lateral Economics” turns up only in the list of submissions. I’m hoping to attend the public hearings on the draft report in the hope that the commissioners might be able to help me better understand why these ideas are not worth considering.

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